Research Topics

Explosion in the 1990s versus Implosion in the 2000s

Orthodox and heterodox theories of financial crises are hereby compared from a theoretical viewpoint, with emphasis on their genesis. The former view (represented by the fourth-generation models of Paul Krugman) reflects the neoclassical vision whereby turbulence is an exception; the latter insight (represented by the theories of Hyman P. Minsky) validates and extends John Maynard Keynes’s vision, since it is related to a modern financial world. The result of this theoretical exercise is that Minsky’s vision represents a superior explanation of financial crises and current events in financial systems because it considers the causes of financial crises as endogenous to the system. Crucial facts in relevant financial crises are mentioned in section 1, as an introduction; the orthodox models of financial crises are described in section 2; the heterodox models of financial crises are outlined in section 3; the main similarities and differences between orthodox and heterodox models of financial crises are identified in section 4; and conclusions based on the information provided by the previous section are outlined in section 5. References are listed at the end of the paper.

The Case of India

India has been experiencing rising inflows of overseas capital since the deregulation of its financial sector. Often looked upon as a success story among other emerging economies, the country has been subject to pitfalls and trilemmas that deserve attention. It has been officially recognized by the Governors of RBI that the financial crisis in India reflects the “dirty face” of what is described in the literature as the impossible trinity, along with the volatility in the markets that was caused by speculative capital in search of profits. However, Joseph Stiglitz observed that India’s policymakers, “particularly the Reserve Bank of India, are already doing a great job. I wish the US Federal Reserve displayed the same understanding of the role of regulation that the RBI has done, at least so far.” Recently, the United States made a path-breaking move with the launching of the recent bill on the regulation of Wall Street, which was passed by a majority of the Senate on May 20, 2010. We urge the implementation of similar laws in India and other emerging economies, especially in view of the fact that the recent moves for financial deregulation in these countries have, rather, been in the opposite direction.

A Keynes-Minsky Episode?

The enormity and pervasiveness of the global economic crisis that began in 2008 makes it relevant to analyze the circumstances that can explain this catastrophe. This will also provide clues to the appropriate remedial measures needed to prevent future occurrences of similar developments.

The paper begins with some theoretical concerns relating to factors that could trigger a similar crisis. The first of these concerns relates to the deregulated financial institutions and the growing uncertainty that can be witnessed in these liberalized financial markets. The secondrelates to financial engineering with innovations in these markets, simultaneously providing cushions against risks while generating flows of liquidity that remain beyond the conventional sources of bank credit.

Interpreting the role of uncertainty, one can observe the connections between investment and finance, both of which are subject to changes in the state of expectations. The initial formulation can be traced back to John Maynard Keynes’s General Theory (1936), where liquidity preference is linked to asset prices and new investments. The Keynesian analysis of the impact of uncertainty related expectations was reformulated in 1986 by Hyman P. Minsky, who introduced the possibility of sourcing external finance through debt, which further adds to the impact of uncertainty. Minsky’s characterization of deregulated financial markets considers the newfangled sources of nonbank credit, especially with the involvement of banks in the securities market under the universal banking model.

As for the institutional arrangements that provide for profits on transactions, financial assets bought and sold in the primary market as initial public offerings of stocks are usually transacted later, in the secondary market, where these are no longer backed by physical assets.In the upswing, finance creates a myriad of financial claims and liabilities, and thus becomes increasingly remote from the real economy, while innovations to hedge and insulate assets continue to proliferate in the financial market, especially in the presence of uncertainty.

The paper dwells on an account of the pattern of the financial crisis and its spread in the United States. This is appended by a stylized account of the turn of events in terms of a theoretical model that highlights the role of uncertainty in the process.

The Methodological Puzzles of the Financial Instability Analysis

The recent revival of Hyman P. Minsky’s ideas among policymakers, economists, bankers, financial institutions, and the mass media, synchronized with the increasing gravity of the subprime financial crisis, demands a reappraisal of the meaning and scope of the “financial instability hypothesis” (FIH). We argue that we need a broader approach than that conventionally pursued, in order to understand not only financial crises but also the periods of financial calm between them and the transition from stability to instability. In this paper we aim to contribute to this challenging task by restating the strictly financial part of the FIH on the basis of a generalization of Minsky’s taxonomy of economic units. In light of this restatement, we discuss a few methodological issues that have to be clarified in order to develop the FIH in the most promising direction.

The Core of the Financial Instability Hypothesis in Light of the Subprime Crisis

This paper aims to help bridge the gap between theory and fact regarding the so-called “Minsky moments” by revisiting the “financial instability hypothesis” (FIH). We limit the analysis to the core of FIH—that is, to its strictly financial part. Our contribution builds on a reexamination of Minsky’s contributions in light of the subprime financial crisis. We start from a constructive criticism of the well-known Minskyan taxonomy o f financial units (hedge, speculative, and Ponzi) and suggest a different approach that allows a continuous measure of the unit’s financial conditions. We use this alternative approach to account for the cyclical fluctuations of financial conditions that endogenously generate instability and fragility. We may thus suggest a precise definition of the “Minsky moment” as the starting point of a Minskyan process—the phase of a financial cycle when many financial units suffer from both liquidity and solvency problems. Although the outlined approach is very simple and has to be further developed in many directions, we may draw from it a few policy insights on ways of stabilizing the financial cycle.

International financial flows are the propagation mechanism for transmitting financial instability across borders; they are also the source of unsustainable external debt. Managing volatility thus requires institutions that promote domestic financial stability, ensure that domestic instability is contained, and guarantee that international institutions and rules of the game are not themselves a cause of volatility. This paper analyzes proposals to increase stability in domestic markets, in international markets, and in the structure of the international financial system from the point of view of Hyman P. Minsky’s financial instability hypothesis, and outlines how each of these three channels can produce financial fragility that lays the system open to financial instability and financial crisis.